Chapter 9—Receivables 9—Receivables CHAPTER OVERVIEW In Chapter 8 you learned about the importance of internal control, with the specific application of internal control procedures

Chapter 9—Receivables CHAPTER OVERVIEW In Chapter 8 you learned about the importance of internal control, with the specific application of internal control procedures to cash and other highly liquid current assets. Chapter 9 extends the discussion to include other current assets, specifically receivables⎯both accounts and notes. Chapter 10 will cover capital assets. The learning objectives for this chapter are to:

1. Design internal controls for receivables. 2. Use the allowance method to account for uncollectibles, and estimate uncollectibles by the

percent-of-sales and the aging-of-accounts-receivable methods. 3. Explain the direct write-off method to account for uncollectibles. 4. Account for credit-card and debit-card sales. 5. Account for notes receivable. 6. Report receivables on the balance sheet. 7. Use the acid-test ratio and days’ sales in receivables to evaluate a company.

Chapter 9 Appendix

8. Discount a note receivable. CHAPTER REVIEW Receivables arise when goods or services are sold on credit. The basic types of receivables are accounts receivable and notes receivable. Accounts receivable are amounts that customers owe a business for purchases made on credit. They should be collectible according to a firm’s normal terms of sale, such as net 30 days. Accounts receivable are sometimes called trade receivables, and they are current assets. Notes receivable occur when customers sign formal agreements to pay for their purchases. These agreements are called promissory notes, and they usually extend for periods of 60 days or longer. The portion of notes receivable scheduled to be collected within a year is a current asset; the remaining amount is a long-term asset. Other receivables include miscellaneous items such as loans to employees. (Helpful hint: Review Exhibit 9-1 in your text for the correct statement placement of these receivables.) Objective 1 - Design internal controls for receivables. The main issues in controlling and managing the collection of receivables are:

1. extending credit only to creditworthy customers 2. separating cash-handling, credit, and accounting duties 3. pursuing collection from customers to maximize cash flow

Chapter 8 Copyright © 2007 Pearson Education Canada

234

The main issues in accounting for receivables are:

1. measuring and reporting receivables at the net realizable value (the amount we expect to collect) 2. measuring and reporting the expense associated with uncollectible accounts

It is imperative that cash-handling and cash accounting duties be separated; otherwise, too many opportunities exist for employees to steal cash from the company. This is true in both the receivables department and the credit department. Extending credit to customers involves the risk that some customers will not pay their obligations. Uncollectible-account expense (also called Doubtful Account Expense or Bad Debt Expense) occurs when a business is unable to collect from some credit customers. This expense is a cost of doing business, and it should be measured, recorded, and reported. Two methods used by accountants are the allowance method and the direct write-off method. The allowance method is the preferred way to account for Uncollectible-account expense (it is better for matching the expense with revenue earned). This method estimates and records collection losses before specific uncollectible accounts are identified. Allowance for Uncollectible Accounts is a contra account to Accounts Receivable. Remember, contra accounts are subtracted from a related account. Examples from earlier chapters are Accumulated Amortization (which is subtracted from a related plant asset) and Sales Discounts (which is subtracted from Sales Revenue). On the balance sheet, Accounts Receivable would appear as follows:

Accounts Receivable XXX - Allowance for Doubtful Accounts (XX) = Net Accounts Receivable XXX

Objective 2 - Use the allowance method to account for uncollectibles, and estimate uncollectibles by the percent-of-sales and aging-of-accounts-receivable methods. Using the allowance method requires an estimate of uncollectible accounts. The percent-of-sales method estimates uncollectible accounts as a percentage of sales, using past experience to set the percentage. This method is called the income statement approach. The amount of the journal entry is equal to credit sales times the bad debt percentage, and is recorded as:

Bad-Debt Expense XX Allowance for Doubtful Accounts XX Aging the accounts involves grouping accounts receivable according to the length of time they have been outstanding. Accounts are usually grouped into 30-day increments, such as 1-30, 31-60, 61-90, and over 90 days. Different percentages of the total receivables in each group are estimated to be uncollectible. The amount for each group is equal to the total receivables in that group times the estimated uncollectible percentage for that group. This method is called the balance sheet approach. Review Exhibit 9-2 in your text. The amount of the journal entry will be what is needed to bring the Allowance account to the estimated amount calculated using the aging method. Therefore, if the existing balance in the Allowance for Doubtful Accounts is a credit, the amount of the journal entry will be less than the estimate. If the existing

Copyright © 2007 Pearson Education Canada Receivables 235

balance in the Allowance for Doubtful Accounts is a debit, the amount of the journal entry will be greater than the estimate. The expense is recorded as:

Bad-Debt Expense XX Allowance for Doubtful Accounts XX Study Tip: When using an estimate based on sales, adjust for the estimate; when using an estimate based on accounts receivable, adjust to the estimate. (Review Exhibit 9-3 in your text.) When using the allowance method, specific accounts receivable are written off when the credit department determines that the receivable is not collectible. Specific accounts are written off with this journal entry:

Allowance for Doubtful Accounts XX Accounts Receivable XX Note that this entry has no effect on total assets, liabilities, revenues or expenses for the period. Objective 3 - Explain the direct write-off method to account for uncollectibles. Using the direct write-off method, the company writes off an account receivable directly to an expense account. In other words, the allowance account is not used. The journal entry for a direct write-off is: Bad-Debt Expense XX Accounts Receivable XX The direct write-off method is easy to use. Its major drawback is that the bad-debt expense is not matched with the revenues to which it pertains because the expense is usually recorded long after the corresponding revenue is recorded. In addition, it shows receivables at their full amount on the balance sheet, not their net realizable value. Occasionally a business will collect an account receivable that has already been written off. When this occurs two journal entries are required, as follows:

Accounts Receivable - Customer A XX Allowance for Doubtful Accounts XX

Cash XX

Accounts Receivable - Customer A XX The first entry reinstates the receivable and returns to the Allowance account the amount used when the account was originally written off. The second entry records the cash received from the customer. If you collapse the entries into one, as follows, important payment information concerning the customer is not in the company’s records.


236

Cash XX

Allowance for Doubtful Accounts XX In the retail industry, credit-card usage has become universal. Credit cards enable merchants to reduce the risk of uncollectible accounts and to eliminate accounts receivable subsidiary ledgers. Objective 4 – Account for credit-card and debit-card sales. When a customer presents a credit-card as payment for a purchase, a sales slip is prepared. The merchant keeps one copy, the customer keeps one copy, and one copy is forwarded to the credit-card company. The credit-card company charges the merchant a fee for processing the charge sale. This fee is usually a percentage of sales, and ranges up to 5%. The merchant records: Credit-Card Discount Expense XX

Accounts Receivable - Credit-Card Co. XX Sales Revenue XX When the credit-card company receives the charge slips, it processes them, bills its cardholders, and reimburses the merchant. The merchant records this entry: Cash XX Accounts Receivable - Credit-Card Co. XX Debit-card sales are treated differently from the credit-card sales treated above. When a customer uses a bankcard, the transaction is immediately recorded at both the bank and the merchant. Therefore, the transaction is similar to a cash sale because the business receives its cash at the point of sale. Objective 5 - Account for notes receivable. Notes receivable are more formal than accounts receivable. Usually, the maker (debtor) will sign a promissory note and must pay the principal amount plus interest to the payee (creditor) on the maturity date. The maturity value is the sum of the principal amount plus the interest. Review Exhibit 9-4 in your text to be certain you are familiar with the following terms: Promissory note Interest period (note period or note term) Maker Maturity date (due date) Payee Maturity value Principal amount Interest rate Interest The formula for computing interest is: Principal × Interest Rate × Time = Interest Amount Study the examples in the text. It is important to be able to compute interest based on years, months, and days. Generally notes arise from three events, as follows:


1) Notes Receivable XX Sales XX Sold goods and received a promissory note. 2) Notes Receivable XX Accounts Receivable XX Receipt of a note from a customer in payment of the account. 3) Notes Receivable XX Cash XX Loaned money and received a promissory note. Interest revenue is earned as time passes, and not just when cash is collected. If the interest period of the note extends beyond the current accounting period, then part of the interest revenue is earned in the current accounting period and part is earned in the next accounting period. Interest must be accrued (you were introduced to accrued revenue in Chapter 3) for the amount that has been earned in the current period but not yet collected. The entry to record accrued interest is:

Interest Receivable XX Interest Revenue XX On the maturity date, the payee will record collection of the note with this entry: Cash XX Notes Receivable XX Interest Receivable XX Interest Revenue XX This entry records: 1) the amount of cash received; 2) the collection of the note; 3) the collection of the interest receivable from the prior accounting period; and 4) the collection of the remaining interest revenue earned in the current accounting period. If the maker of the note does not pay at maturity, the maker has dishonoured (defaulted on) the note. The note agreement is no longer negotiable, but the payee (creditor) still has a claim against the maker (debtor). The payee usually transfers the claim from Notes Receivable to Accounts Receivable and records the interest revenue earned: Accounts Receivable XX

Notes Receivable XX Interest Revenue XX


238

Objective 6 - Report receivables on the balance sheet. Firms report the value of accounts receivable on the balance sheet in various ways: 1. As a net value: Accounts Receivable (less Allowance of $XX for Uncollectibles) $XXX 2. With footnotes: Accounts Receivables (note X) $XXX 3. With detail in the body of the balance sheet: Accounts Receivable $XXX Less: Allowance for Doubtful Accounts XX $XXX Objective 7 - Use the acid-test ratio and the days’ sales in receivables to evaluate a company. The acid-test (quick) ratio measures the ability of a business to pay all of its current liabilities if they become due immediately. Acid-test Ratio = Cash + Short-term investments + Net current receivables Current Liabilities Study Tip: Remember that inventory, supplies, and prepaid expenses are not used to compute the acid-test ratio. Days’ sales in receivables (also called the collection period) measures the average days an account receivable is outstanding. One day’s sales = Net Sales 365 Days’ sales in average accounts receivable = Average Net Accounts Receivable One day’s sales Average Net Accounts Receivable = Beginning Receivables + Ending Receivables 2 Chapter Appendix: Discounting a Note Receivable A note receivable is a negotiable instrument. Frequently, a business will sell a note receivable to a bank to raise cash. Selling a note receivable before its maturity date is called discounting a note receivable. The seller receives less than the maturity value (that is, the seller gives up some of the interest revenue) in exchange for receiving cash. The discounted value, called the proceeds, is the amount the seller (business) receives from the purchaser (bank).

Proceeds are computed as:


Principal amount of the note + Interest (Principal × Rate × Time) (entire length of note) = Maturity Value - Discount (Maturity value × Discount rate × Time) (time bank holds note) = Proceeds

The business records the following entry when selling a note receivable:

Cash XX (Proceeds) Notes Receivable XX (Face Value of Note)

Interest Revenue XX (Difference if Proceeds > Face Value) Sometimes the proceeds are less than the principal amount. In this situation, the entry is:

Cash XX Interest Expense XX Notes Receivable XX Review Exhibit 9A-1 in your text.


240

TEST YOURSELF All the self-testing materials in this chapter focus on information and procedures that your instructor is likely to test in quizzes and examinations. Questions followed by the letter A refer to material in the chapter appendix. I. Matching Match each numbered term with its lettered definition. _____ 1. aging of accounts receivable _____ 11. allowance method _____ 2. Allowance for Doubtful Accounts _____ 12. creditor _____ 3A. discount amount on note receivable _____ 13. debtor _____ 4. direct write-off method _____ 14. dishonour a note _____ 5A. discounting a note receivable _____ 15. interest period _____ 6. interest _____ 16. maker of a note _____ 7. maturity date _____ 17. maturity value _____ 8. payee _____ 18. principal amount _____ 9. promissory note _____ 19. receivable _____ 10. Bad-debt expense _____ 20. interest rate A. a bank’s interest revenue from holding the note B. the party to a credit transaction who obtains a receivable C. the party to a credit transaction who makes a purchase and credits a payable D. failure of the maker of a note to pay at maturity E. a method of accounting for uncollectible accounts in which the company records bad-debt expense

and credits the customer’s account receivable when the credit department decides that a customer’s account receivable is uncollectible

F. selling a note receivable before its maturity G. revenue to the payee for loaning out the principal, and expense to the maker for borrowing the

principal H. the person who signs a note and promises to pay the amount required by the note agreement I. the date on which the final payment of a note is due J. the person who receives promised future payment on a note K. the amount loaned out or borrowed L. a written promise to pay a specified amount of money on a particular future date M. a monetary claim against a business or an individual that is acquired by selling goods and services

on credit or by lending money N. a way to estimate uncollectible accounts by analyzing individual accounts receivable according to

the length of time they have been due O. a contra asset account related to Accounts Receivable P. a method of recording collection losses based on estimates made prior to determining that specific

accounts are uncollectible Q. the percentage rate multiplied by the principal amount to compute the amount of interest on a note R. the time during which interest is computed S. the sum of the principal and interest due at the maturity of a note T. cost of extending credit that arises from the failure to collect from credit customers


II. Multiple Choice Circle the best answer. 1. Using the allowance method, writing off a specific account receivable will: A. increase net income C. not affect net income B. decrease net income D. affect net income in an undetermined manner 2. Bad-Debt Expense is: A. a component of Cost of Goods Sold C. a reduction to Sales B. an operating expense D. an Other Expense 3. Which of the following will occur if Bad-Debt Expense is not recorded at the end of the year? A. Expenses will be overstated. C. Liabilities will be understated. B. Net income will be understated. D. Assets will be overstated. 4. Net Accounts Receivable is equal to: A. Accounts Receivable - Allowance for Doubtful Accounts B. Accounts Receivable + Allowance for Doubtful Accounts C. Accounts Receivable – Bad-Debt Expense D. Accounts Receivable + Bad-Debt Expense 5. Accounts Receivable has a debit balance of $45,000 and the Allowance for Doubtful Accounts has a

credit balance of $3,000. A specific account of $400 is written off. What is the amount of net receivables after the write-off?

A. $44,600 C. $42,000 B. $42,600 D. $41,600 6. Allowance for Doubtful Accounts is: A. an expense account C. a contra asset account B. a contra liability account D. a liability account 7. A 120-day note receivable reported on the balance sheet is classified as a: A. current asset C. current liability B. long-term asset D. long-term liability 8. Interest is equal to: A. Principal × Rate C. Principal × Rate ÷ Time B. Principal ÷ Rate ÷ Time D. Principal × Rate × Time


242

9A. When a company discounts a note receivable, how much cash is typically received? A. more than the maturity value C. less than the maturity value B. the maturity value D. the principal amount 10. Which of the following does not describe a business’s cost of extending credit to customers who do

not pay? A. Bad Debt Expense C. Account Receivable Expense B. Uncollectible-Account Expense D. Doubtful Account Expense III. Completion Complete each of the following statements. 1. The direct write-off method of accounting for uncollectible accounts violates the

________________________ principle. 2. _________________ are the same before and after the write-off of uncollectible accounts. 3. The method of estimating uncollectible accounts that focuses on the balance sheet is the

__________________ method. 4. The method of estimating uncollectible accounts that focuses on the income statement is the

________________ method. 5A. The _____________ value of a note is calculated by adding the ______________ plus _________. 6. If the maker of a note does not pay the note receivable at maturity, the maker is said to have

____________________ the note. 7. The _________________________ measures the ability of a business to pay all its current

liabilities if they become due immediately. 8. To calculate the average days an account receivable is outstanding, average net accounts receivable

is divided by _______________________________. 9. On a promissory note, the person signing the note is called the ___________________ and the

person (a business) to whom the promise of payment is being made is called the __________. 10A. The discount period refers to the length of time _______________________________.


IV. Daily Exercises 1. Sal’s Salon uses the allowance method to account for uncollectible accounts. Indicate the effect that

each of the following transactions will have on gross Accounts Receivable, the Allowance for Doubtful Accounts, net Accounts Receivable, and Bad-Debt Expense. Use + for increases and - for decreases, and 0 for no effect.

Gross

Accounts Receivable

Allowance for Doubtful

Accounts

Net Accounts

Receivable

Bad-Debt Expense

An account receivable is written off

An account receivable is reinstated

A customer pays his account receivable

1.75% of $1,800,000 in sales is estimated to be uncollectible

5% of $120,000 in accounts receivable is estimated to be uncollectible (the balance in the Allowance account is a credit of $600)

2. Compute the missing amounts. Use the 365-day year. Round to nearest dollar.

Principal Interest rate Duration Interest Maturity Value

A. $ 6,000 12% 3 months B. $20,000 9% 90 days C. 6% 30 days $18,089 D. $16,000 6 months $640


244

3. From the following list, present the current asset section of the balance sheet:

Accounts receivable (short-term) $ 84,400 Accounts receivable (long-term) 110,000 Allowance for doubtful accounts 5,270 Cash 165,090 Inventory 227,420 Marketable securities 61,200 Notes receivable (60-days) 18,000 Notes receivable (2-year) 32,000 Prepaid expenses 17,973

4. From the items in Daily Exercise #3, list those that would be used in calculating the acid-test ratio. 5. Urbanski Co. uses an allowance method in accounting for uncollectible accounts. Three months ago,

it wrote off a $4,150 receivable from customer Stein. In today’s mail, Urbanski receives a cheque from Stein for the entire amount along with a note apologizing for the delay in paying the delinquent invoice. Record the entry for the $4,150 cheque from Stein.

6. Review the circumstances in #5 above, but assume Urbanski Co. uses the direct write-off method for

uncollectible accounts. Record the entry for the $4,150 payment.


V. Exercises 1. Solano Solutions has a $210,000 balance in Accounts Receivable on December 31, 2008. The

Allowance for Doubtful Accounts has a $700 credit balance. Credit sales totaled $650,000 for the year.

a. If Solano Solutions uses the percent of sales method and estimates that 1.5% of sales may be

uncollectible, what is the bad-debt expense for 2008? b. What is the ending balance in the Allowance for Doubtful Accounts after adjustments?

c. Would your answer be different if the Allowance for Doubtful Accounts had a $700 debit balance?

2. Assume the same account balances in Exercise #1 for Solano Solutions:

a. If Solano Solutions uses the aging-of-accounts receivable method and has determined that $11,000 of Accounts Receivable are uncollectible, what is the bad-debt expense for 2005?

b. What is the ending balance in the Allowance for Doubtful Accounts after adjustments?


246

c. Would your answers be different if the Allowance for Doubtful Accounts had a $700 debit balance?

3A. An $18,000, 90-day, 9% note is discounted at the bank at 12%, 30 days before maturity. What is the

appropriate journal entry? 4. From the following information, calculate

a) acid-test ratio b) days’ sales in receivables

Debit CreditCash 28,000 Short-term investments 135,000 Beginning accounts receivable 225,000 Beginning allowance for doubtful accounts 9,000 Ending accounts receivable 282,000 Ending allowance for doubtful accounts 9,400 Inventory 961,500 Prepaid expenses 43,920 Other current assets 22,860 Current liabilities 301,400 Sales 3,826,900 Sales discounts 19,725 Sales returns and allowances 84,490


VI. Beyond the Numbers Review the information given in Exercise #3 above, but assume the interest rate and discount rate were reversed. Therefore, in Exercise #3, the note carried a 12% interest rate while the bank was offering a 9% discount. At what point during the term of the note should the business discount the note? Support your answer. VII. Demonstration Problems Demonstration Problem #1 Tesla, Inc. manufactures electrical components. The company’s year-end trial balance for 2008 reported the following:

Debit Credit Accounts Receivable 3,125,200 Allowance for Doubtful Accounts 62,050

Assume that net credit sales for 2008 amounted to $39,750,000 and Allowance for Doubtful Accounts has not yet been adjusted for 2008. Required: 1. At the end of 2008, the following accounts receivable were deemed uncollectible: Sanchez Inc. $ 5,125 Bui Corporation 9,360 Jasper Products 7,140 NXT Co. 10,010 Total $31,635 Prepare the 2008 journal entry necessary to write off the above accounts. 2. Assume that the company uses the percent of sales method to estimate Bad-Debt Expense. After

analyzing industry averages and prior years’ activity, management has determined that Bad-Debt Expense for 2008 should be 0.5% of net credit sales. Prepare the journal entry to record and adjust Bad-Debt Expense.

3. Show the balance sheet presentation for Accounts Receivable after the adjustment in #2 has been

posted. 4. Assume that the company uses the aging of accounts receivable method. The aging schedule prepared

by the company’s credit manager indicated that an Allowance of $205,000 for uncollectible accounts is appropriate. Prepare the appropriate journal entry.


248

5. Show the balance sheet presentation for Accounts Receivable after the adjustment in #4 has been posted.

6. Calculate the days’ sales in receivables assuming the adjustment in #4 above and beginning net

receivables were $2,742,107. Requirement 1 (Write-off of uncollectible accounts) Date Accounts and Explanation PR Debit Credit Requirement 2 (Adjustment to record Bad-Debt Expense using the percent of sales method) Date Accounts and Explanation PR Debit Credit Requirement 3 (Balance sheet presentation) Requirement 4 (Adjustment to record Bad-Debt Expense using the aging-of-accounts method) Date Accounts and Explanation PR Debit Credit


Requirement 5 (Balance sheet presentation) Requirement 6 (Days’ sales in receivables) Demonstration Problem #2 Antonio Santini’s is a high-end men’s clothing store. Santini’s accounting period ends on January 31. During fiscal years 2007 and 2008, the following selective transactions occurred: 2007 fiscal year Apr. 1,2006 Loaned $24,000 to Western Woolens, a supplier. Santini received a one-year, 10%

note. Jun. 10,2006 Sold $8,500 merchandise on account to R. B. Reid, terms n/30. The cost of the sale

was $2,350. Jul. 10,2006 Received a 90-day, 12% note from R. B. Reid in payment of the account. Oct. 8, 2006 Reid paid the interest due on his note and replaced the old note with a new note for 120

days at 12% interest. Nov. 1, 2006 Loaned $15,000 to a supplier, Ted’s Threads. Received a 150-day note at 9% interest. Jan.15,2007 Discounted the Threads note at the bank. The bank charged a 12% discount rate. 2008 fiscal year Feb.5, 2007 Reid dishonoured his note. Mar.31,2007 The bank notified Santini that Ted’s Threads paid their note. Apr. 1,2007 Western Woolens paid their note. Jun. 10,2007 After numerous attempts to collect Reid’s debt, the account was written off. Santini

uses the allowance method. Required: 1. Prepare the necessary journal entries to record Santini’s transactions for the 2007 fiscal year. 2. Prepare any adjusting entries needed on January 31, 2007, the end of the fiscal period (note the period

ends on January 31 and not December 31 – this is common in retailing). 3. Record the 2008 fiscal year entries.


250

Requirement 1 (2007 fiscal year entries) GENERAL JOURNAL

Date Accounts and Explanation PR Debit Credit Requirement 2 (January 31, 2007, adjusting entries)

GENERAL JOURNAL Date Accounts and Explanation PR Debit Credit


Requirement 3 (2008 fiscal year entries)

GENERAL JOURNAL Date Accounts and Explanation PR Debit Credit


252

SOLUTIONS I. Matching 1. N 5A. F 9. L 13. C 17. S 2. O 6. G 10. T 14. D 18. K 3A. A 7. I 11. P 15. R 19. M 4. E 8. J 12. B 16. H 20. Q II. Multiple Choice 1. C Writing off a specific account receivable using the allowance method takes the form of:

Allowance for Doubtful Accounts XX Accounts Receivable XX Both accounts involved are balance sheet accounts; accordingly, net income is not affected.

2. B Bad-Debt Expense is estimated and recorded as an adjusting entry. It is a function of the

operations of the business and is an operating expense. 3. D Failing to record the Bad-Debt Expense also means that no increase in the Allowance for

Doubtful Accounts (contra accounts receivable) was recorded. Accordingly, expenses are understated and assets are overstated.

4. A Net Accounts Receivable is the result of netting the Accounts Receivable balance against its

contra account, Allowance for Doubtful Accounts. 5. C When Accounts Receivable and the Allowance are both reduced by $400, Net Accounts

Receivable will be unchanged. [$45,000 - $3,000 = ($45,000 - $400) - ($3,000 - $400)]

6. C Allowance for Doubtful Accounts is a companion account to Accounts Receivable and has a

normal credit balance while Accounts Receivable has a normal debit balance. A contra account has two distinguishing characteristics: 1) it always has a companion account, and 2) its normal balance is opposite that of the companion account.

7. A A note receivable is an asset. An asset that will be converted to cash within one year is a

current asset. 8. D Interest is a function of the amount advanced to the borrower, the interest rate, and the term of

the loan. 9A. C Discounting is done to get cash quickly for a note prior to its maturity date by selling the note

to another entity. The entity buying the note will collect the maturity value and will pay less than this for the note when purchased.

10. C Of the items listed, all except “Accounts Receivable Expense” are acceptable account titles

(descriptions) for the business’s cost of extending credit to customers who do not pay.


III. Completion 1. matching (The direct write-off fails to match the business’s cost of extending credit to customers

who do not pay with the revenue generating the expense). 2. Net receivables 3. aging-of-accounts (Aging the accounts focuses on estimating the appropriate balance in the contra

account receivable account, Allowance for Doubtful Accounts.) 4. percent of sales (The percent of sales method focuses on calculating the appropriate cost to match

against sales in the current period as Bad-Debt Expense.) 5A. maturity value, principal, interest 6. dishonoured 7. acid-test (quick) ratio 8. one day’s sales 9. maker, payee 10A. from date of discount to maturity date IV. Daily Exercises 1. Gross

Accounts Receivable

Allowance for Doubtful accounts

Net Accounts

Receivable

Bad-debt Expense

An account receivable is written off

-

-

0

0

An account receivable is reinstated

+

+

0

0

A customer pays his account receivable

-

0

-

0

1.75% of $1,800,000 in sales is estimated to be uncollectible

0

+

-

+ 5% of $120,000 in accounts receivable is estimated to be uncollectible (the balance in the Allowance account is a credit of $600)

0

+

-

+


254

2. A. interest = $6,000 × .12 × 3/12 = $180 maturity value = $6,000 + $180 = $6,180 B. interest = $20,000 × .09 × 90/365 = $444 maturity value = $20,000 + $444 = $20,444 C. maturity value = principal + interest interest = principal × rate × time $18,089 = P + (P × .06 × 30/365) P = $18,000 interest = $89 D. interest = principal × rate × time $640 = $16,000 × R × 6/12 R = 8% maturity value = principal + interest maturity value = $16,000 + $640 = $16,640 3.

Cash $165,090 Marketable securities 61,200 Accounts receivable 84,400 Less: Allowance for doubtful accounts 5,270 79,130 Notes receivable 18,000 Inventory 227,420 Prepaid expenses 17,973 $568,813

4. The acid-test ratio only uses those current assets that can be converted into cash quickly; therefore,

the following would be included: Cash, Marketable Securities, Accounts Receivable (net), and Notes Receivable.

For most businesses, inventory is not considered a quick asset and prepaid expenses are never

included. 5. When a previously written off receivable is collected, two entries are required. One entry reinstates

the receivable, while the second entry records the collection.

Accounts Receivable – Stein 4,150 Allowance for Doubtful Accounts 4,150 To reinstate the Stein account Cash 4,150 Accounts Receivable – Stein 4,150 To record collection of the Stein account


6. Accounts Receivable – Stein 4,150 Bad Debt Expense 4,150 Cash 4,150 Accounts Receivable – Stein 4,150

V. Exercises 1.

a. Bad-Debt Expense = .015 × $650,000 = $9,750 b. Ending balance in Allowance for Doubtful Accounts = $700 + $9,750 = $10,450 c. Yes. The amount of bad-debt expense would be the same. However, the balance in the Allowance

for Doubtful Accounts would be different ($9,750 - $700 = $9,050). 2.

a. The current balance in the Allowance account is $700 credit and the desired balance in the Allowance account is $11,000 credit. The bad-debt expense will be $11,000 - $700 = $10,300.

b. The ending balance will be $11,000. c. Yes. It would require a credit of $11,700 to bring the balance in the Allowance account to a credit

of $11,000; the corresponding debit is to the bad-debt expense. The ending balance in the Allowance account will be the same, $11,000.

3A.

Cash 18,217.98 Interest Revenue 217.98 Note Receivable 18,000.00

maturity value = $18,000 + ($18,000 × .09 × 90/365) = $18,399.45 discount = $18,399.45 × .12 × 30/365 = $181.47 proceeds = $18,399.45 - $181.47 = $18,217.98 4.

a) acid-test ratio = Quick assets ÷ Current liabilities quick assets = Cash + Short-term investments + Net accounts receivable = [28,000 + 135,000 +

(282,000 – 9,400)] = 435,600 acid-test ratio = 435,600 ÷ 301,400 = 1.45 (rounded)

b) days’ sales in receivables = (Average net receivables ÷ Net sales) × 365 Average net receivable = [(225,000 – 9,000) + (282,000 – 9,400)] ÷ 2 = (216,000 + 272,600) ÷ 2

= 488,600 ÷ 2 = 244,300 Net sales = Sales – Sales discounts – Sales returns and Allowances = 3,826,900 – 19,725 –

84,490 = 3,722,685 days’ sales in receivables = (244,300 ÷ 3,722,685) × 365 = 24 days (rounded)


256

VI. Beyond the Numbers The business should discount the note (sell it to the bank) as soon as possible, preferably upon receiving the note. Why? Assuming the note is discounted upon receipt, the entry would be: Cash 18,121.33 Interest Revenue 121.33 Note Receivable 18,000.00 (Maturity value is $18,532.60; therefore, the discount is $411.27 = $18,532.60 × 9% × 90/365; proceeds are $18,532.60 - $411.27 = 18,121.33. If you examine the entry carefully, you will see that interest has been earned without the holder (the business) keeping the note for even one day. In other words, when the discount rate is less than the interest rate, a business should sell the note as soon as possible, thereby maximizing the potential return. VII. Demonstration Problems Demonstration Problem #1 Requirement 1 (Write-off of uncollectible accounts) Date Accounts and Explanation PR Debit CreditDec.31,2008 Allowance for Doubtful Accounts 31,635 Accounts Receivable - Sanchez, Inc. 5,125 Accounts Receivable - Bui Corporation 9,360 Accounts Receivable – Jasper Products 7,140 Accounts Receivable - NXT Co. 10,010 To write off uncollectible accounts.


Requirement 2 (Adjustment to record bad-debt expense using the percent of sales method) Bad-Debt Expense 198,750 Allowance for Doubtful Accounts 198,750 Net credit sales of 2008 were $39,750,000. Bad-debt expense for 2008 is therefore $198,750 (39,750,000 × 0.5% = 198,750). An examination of the activity to date in the bad-debt expense and Allowance for Doubtful Accounts reveals the effect of the entries made in Requirements 1 and 2.

Allowance for Bad-Debt Expense Doubtful Accounts Accounts Receivable

(2) 198,750 (1) 31,635 Bal. 62,050 Bal. 3,125,200 (1) 31,635 Bal. 198,750 (2) 198,750 Bal. 3,093,565 Bal. 229,165 Note that the Allowance account started at $62,050. In requirement 1, it was reduced by $31,635 when the uncollectible accounts were written off against the Allowance account. Note that prior to the 2008 adjustment, the allowance was down to $30,415 ($62,050 - $31,635 = $30,415). The allowance was then adjusted upward to $229,165 in Entry 2, when the company recorded 2008 Bad-Debt Expense of $198,750. Requirement 3 (Balance Sheet representation)

Accounts Receivable 3,093,565 Less: Allowance for Doubtful Accounts 229,165 2,864,400

Requirement 4 (Adjustment to record bad-debt expense using the aging- of-accounts method) Bad-Debt Expense 174,585 Allowance for Doubtful Accounts 174,585 When the aging-of-accounts method is used, the adjustment brings Allowance for Doubtful Accounts to the balance indicated by the aging schedule. Before adjustment, the balance in the Allowance account was $30,415. The facts reveal that the desired balance in the Allowance account should be set at $205,000. The difference between the unadjusted balance and the desired balance ($205,000 - $30,415 = $174,585) represents the amount of the adjustment and the amount of expense. Study Tip: When using the percent-of-sales method, adjust for the estimate. When using aging-of-accounts method as a basis for the estimate, adjust to the estimate (i.e., the estimate should be the balance in the Allowance account after the adjusting entry is posted).


258

Requirement 5 (Balance Sheet representation)

Accounts Receivable 3,093,565 Less: Allowance for Doubtful Accounts 205,000 2,888,565

Requirement 6 (Days’ Sales in Receivable) Sales in receivables = Average net Accounts Receivable ÷ One day’s sales One day’s sales = Net sales ÷ 365 = $39,750,000 ÷ 365 = $108,904 (rounded) Average net Accounts Receivable = ($2,742,107 + $2,888,565) ÷ 2 = $2,815,336 Days’ sales in receivables = $2,815,336 ÷ $108,904 = 25.9 days Demonstration Problem #2 Solved and Explained Requirement 1 (2007 fiscal year entries) Apr.1, 2006 Note Receivable 24,000 Cash 24,000

Western Woolens, 1-year, 10% Jun. 10, 2006 Accounts Receivable – Reid 8,500 Sales 8,500 Cost of Goods Sold 2,350 Inventory 2,350 Jul. 10, 2006 Note Receivable 8,500 Accounts Receivable – Reid 8,500 Reid, 90-day, 12% Oct.8, 2006 Cash 251.51 Note Receivable 8,500 Interest Revenue 251.51 Note Receivable 8,500 Nov.1, 2006 Note Receivable 15,000 Cash 15,000 Ted’s Threads, 150 days, 9% Jan. 15, 2007 Cash 15,171.25 Note Receivable 15,000 Interest Revenue 171.25 See explanation below


Requirement #2 – Jan. 31, 2007 adjusting entries Interest Receivable 2,000 Interest Revenue 2,000 Woolens note ($24,000 x 10% x 10/12) Interest Receivable 321.37 Interest Revenue 321.37 Reid note ($8,500 × 12% × 115/365)

No entry required on the Threads note as it was sold (discounted) to the bank on Jan. 15,2007; therefore, the bank owns the note.

Requirement #3 (2008 fiscal year entries) Feb. 5, 2007 Account Receivable - Reid 8,835.34 Note Receivable 8,500.00 Interest Receivable 321.37 Interest Revenue 13.97 Apr. 1, 2007 Cash 26,400 Note Receivable 24,000

Interest Receivable 2,000 Interest Revenue 400

Jun 10, 2007 Allowance for Doubtful Accts. 8,835.34 Accounts Receivable - Reid 8,835.34 Explanations: When a note receivable is discounted the bank charges a fee (the discount rate) to the maturity value of the note. Therefore, to determine the amount of proceeds, follow these steps: 1. Calculate the maturity value of the note 2. Calculate the discount 3. Calculate the proceeds For the Ted’s Threads note, the above steps result in the following: 1. $15,000 × 9% × 150/365 = $15,554.79 2. $15,554.79 × 12% × 75/365 = $383.54 3. $15,554.79 - $383.54 = $15,171.25


260

Chapter 9—Receivables 9—Receivables CHAPTER OVERVIEW In Chapter 8 you learned about the importance of internal control, with the specific application of internal control procedures

Documents